Question on Interest only loans..

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Question on Interest only loans..

Raden Mantuano
Member since 2018 · 53 posts · 10 votes

Hey everyone! 

So for those of you who’ve followed my previous post on getting my first rental property via seller finance, I wanted to follow up and get some insight on some of the terms we’ve agreed upon and accepted (In escrow now) the terms are as follows.

Purchase price $44k

Down $500

Note $43,500 financed at 8.5%

9 year interest only payments $308.13

balloon payment of principal at the end of year 9 (refinance)

Rent $650-$680

Property Management: 10% - $65/mo

Insurance: $43.75

Taxes: $340.20/yr = $28.35/mo

Vacancy Rate: 8.8% - $57.20/mo

Capex aka Repairs: 5% - $32.50/mo

Netting between: $115.07 and $215ish (not the best but something) 

My question is, with the terms agreed upon, I realized that because I’m paying interest only (Cashflow purposes) for 9 years and having to pay the full principal amount in 9 years, Does this mean I’m depending on the market appreciating? What happens if the market barely appreciates and I’m at year 9? What if it’s gone up only $5k, does this mean I have to come up with $38,500 somehow? Can I still refinance? Or are there other ways to pay the principal off? 

I was hoping to save the cashflow to get more properties... 

When the seller and I were going back and fourth I was totally going for more of the cashflow and acquiring the property with low to no money down during our negotiation...

I also was thinking if I just snow balled and used the cashflow to get more properties that are also cash flowing I can easily just have the balloon payment 9 years from now..

Thanks for your help guys! 

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Nathan GesnerBusiness Member
Moderator
Real Estate Broker · Cody, WY · Member since 2010 · 28k+ posts · 41k+ votes
7y

I don't think you're ready. According to your other post, you had to borrow from family just to obtain the $500 earnest money deposit. This indicates you have nothing saved as a reserve and are banking on the tenant's rent to help you save up.

In reality, most homes have problems after purchase. It sits vacant for two months. An appliance breaks. The furnace goes out and requires repairs or replacement. In almost every property I've ever bought, there were unexpected expenses within the first six months even though I did a property inspection with a professional.

How are you going to float the payment each month if it's vacant? If no tenant, you will still have to pay the mortgage, taxes, and insurance. You also have utilities which I assume could run at least $150 a month in the winter. This will cost you as much as the earnest money deposit every month! Are you going to borrow that from family?

I regularly tell people it is a mistake to put your last dime into buying a home. It's even worse to borrow money to purchase a home because now you are indebted to two people and you still don't have funds to handle an emergency.

I recommend you find a reason to get the earnest money back, pay off your family, and focus on saving and preparing for your purchase instead of trying to borrow your way to wealth. If you can't save $500 for a deposit and a reserve fund of at least three months vacancy then I think you're asking for trouble.

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  • Alex S.
    Specialist · Cleveland, OH · Member since 2018 · 270 posts · 187 votes
    7y

    Why borrow at 8.5% from the seller when you can borrow from the bank at 5%?

    6Reply
  • Nathan GesnerBusiness Member
    Moderator
    Real Estate Broker · Cody, WY · Member since 2010 · 28k+ posts · 41k+ votes
    7y

    I don't think you're ready. According to your other post, you had to borrow from family just to obtain the $500 earnest money deposit. This indicates you have nothing saved as a reserve and are banking on the tenant's rent to help you save up.

    In reality, most homes have problems after purchase. It sits vacant for two months. An appliance breaks. The furnace goes out and requires repairs or replacement. In almost every property I've ever bought, there were unexpected expenses within the first six months even though I did a property inspection with a professional.

    How are you going to float the payment each month if it's vacant? If no tenant, you will still have to pay the mortgage, taxes, and insurance. You also have utilities which I assume could run at least $150 a month in the winter. This will cost you as much as the earnest money deposit every month! Are you going to borrow that from family?

    I regularly tell people it is a mistake to put your last dime into buying a home. It's even worse to borrow money to purchase a home because now you are indebted to two people and you still don't have funds to handle an emergency.

    I recommend you find a reason to get the earnest money back, pay off your family, and focus on saving and preparing for your purchase instead of trying to borrow your way to wealth. If you can't save $500 for a deposit and a reserve fund of at least three months vacancy then I think you're asking for trouble.

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    WebsiteView Page
    19Reply
  • Corby GoadeBusiness Member
    Investor · Boise, ID · Member since 2014 · 3k+ posts · 3k+ votes
    7y

    Good advice from @Nathan Gesner above. To directly answer your question, are you not allowed by the contract to pay more than the interest? If your cash flow allows, why not attack the principle and be done with the loan asap?

    REI is a long term game and there are a few things that I'd like to address about your concerns with equity build up. There are markets, especially lower end markets where you can buy and cash flow a property for $50k, where appreciation is slow to non-existent. Investing in these markets can be tough, and you have to prepare yourself for the fact that you might not see any appreciation.

    Secondly, the REI market goes up and down in cycles. I've been through cycles when I had several properties under water, but rent was covering my expenses. You have to buy properties and put yourself in a financial position that you can weather a storm like that and come through the other side.

    1Reply
  • Raden Mantuano
    OP
    Member since 2018 · 53 posts · 10 votes
    7y
    Originally posted by @Nathan Gesner:

    I don't think you're ready. According to your other post, you had to borrow from family just to obtain the $500 earnest money deposit. This indicates you have nothing saved as a reserve and are banking on the tenant's rent to help you save up.

    In reality, most homes have problems after purchase. It sits vacant for two months. An appliance breaks. The furnace goes out and requires repairs or replacement. In almost every property I've ever bought, there were unexpected expenses within the first six months even though I did a property inspection with a professional.

    How are you going to float the payment each month if it's vacant? If no tenant, you will still have to pay the mortgage, taxes, and insurance. You also have utilities which I assume could run at least $150 a month in the winter. This will cost you as much as the earnest money deposit every month! Are you going to borrow that from family?

    I regularly tell people it is a mistake to put your last dime into buying a home. It's even worse to borrow money to purchase a home because now you are indebted to two people and you still don't have funds to handle an emergency.

    I recommend you find a reason to get the earnest money back, pay off your family, and focus on saving and preparing for your purchase instead of trying to borrow your way to wealth. If you can't save $500 for a deposit and a reserve fund of at least three months vacancy then I think you're asking for trouble.

     Hey Nathan, I appreciate the advice and all that is mentioned has already been accounted for. I do have income coming in, it was just a deal that needed decision right away.. I’m also a realtor and just close a couple deals so I’ll be packing on reserves. 

    0Reply
  • Raden Mantuano
    OP
    Member since 2018 · 53 posts · 10 votes
    7y
    Originally posted by @Alex S.:

    Why borrow at 8.5% from the seller when you can borrow from the bank at 5%?

     It was a trade off for the low to no money down.. 

    0Reply
  • Raden Mantuano
    OP
    Member since 2018 · 53 posts · 10 votes
    7y
    Originally posted by @Corby Goade:

    Good advice from @Nathan Gesner above. To directly answer your question, are you not allowed by the contract to pay more than the interest? If your cash flow allows, why not attack the principle and be done with the loan asap?

    REI is a long term game and there are a few things that I'd like to address about your concerns with equity build up. There are markets, especially lower end markets where you can buy and cash flow a property for $50k, where appreciation is slow to non-existent. Investing in these markets can be tough, and you have to prepare yourself for the fact that you might not see any appreciation.

    Secondly, the REI market goes up and down in cycles. I've been through cycles when I had several properties under water, but rent was covering my expenses. You have to buy properties and put yourself in a financial position that you can weather a storm like that and come through the other side.

     I can run it by the seller cause ide think that would be a good idea. But yes getting into the deal I was more focused on the idea of cashflow, however I mentioned the balloon payment realizing with that strategy I’m depending on appreciation, however Memphis does have a good outlook of appreciation 

    0Reply
  • Caleb Heimsoth
    Rental Property Investor · Durham, NC · Member since 2016 · 7k+ posts · 7k+ votes
    7y

    @Raden Mantuano. Your repairs are way to low. I wouldn’t do this deal. You’re not getting enough rent for that purchase price. Low end homes (50k or less) should be 2 percent rule or better. What happens when the tenant moves out, leaves a bunch of trash behind and you need to repaint and clean it out. There goes all your cash flow

    2Reply
  • Raden Mantuano
    OP
    Member since 2018 · 53 posts · 10 votes
    7y
    Originally posted by @Caleb Heimsoth:

    @Raden Mantuano. Your repairs are way to low. I wouldn’t do this deal. You’re not getting enough rent for that purchase price. Low end homes (50k or less) should be 2 percent rule or better. What happens when the tenant moves out, leaves a bunch of trash behind and you need to repaint and clean it out. There goes all your cash flow

     I have the money accounted for the repairs. However, it is rent ready as Property management has done walk through. 

    0Reply
  • Caleb Heimsoth
    Rental Property Investor · Durham, NC · Member since 2016 · 7k+ posts · 7k+ votes
    7y
    Originally posted by @Raden Mantuano:
    Originally posted by @Caleb Heimsoth:

    @Raden Mantuano. Your repairs are way to low. I wouldn’t do this deal. You’re not getting enough rent for that purchase price. Low end homes (50k or less) should be 2 percent rule or better. What happens when the tenant moves out, leaves a bunch of trash behind and you need to repaint and clean it out. There goes all your cash flow

     I have the money accounted for the repairs. However, it is rent ready as Property management has done walk through. 

    When you say “money accounting for repairs” are you talking about the numbers above?  If so that won’t be enough in the long run.

    It may be rent ready is but it won’t be when the next tenant lives there a couple years then leaves

    1Reply
  • Raden Mantuano
    OP
    Member since 2018 · 53 posts · 10 votes
    7y
    Originally posted by @Caleb Heimsoth:
    Originally posted by @Raden Mantuano:
    Originally posted by @Caleb Heimsoth:

    @Raden Mantuano. Your repairs are way to low. I wouldn’t do this deal. You’re not getting enough rent for that purchase price. Low end homes (50k or less) should be 2 percent rule or better. What happens when the tenant moves out, leaves a bunch of trash behind and you need to repaint and clean it out. There goes all your cash flow

     I have the money accounted for the repairs. However, it is rent ready as Property management has done walk through. 

    When you say “money accounting for repairs” are you talking about the numbers above?  If so that won’t be enough in the long run.

    It may be rent ready is but it won’t be when the next tenant lives there a couple years then leaves

     No, I have reserves and will have more. 

    0Reply
  • Raden Mantuano
    OP
    Member since 2018 · 53 posts · 10 votes
    7y

    I also figured by doing seller financed with little down, I don’t have much risk on my end even if the deal was shot he can decide to take the property back if worse comes to worse.. and I doubt he’d want to be left hold the bag

    0Reply
  • Joe SplitrockPro Member
    Moderator
    Rental Property Investor · Sioux Falls, SD · Member since 2015 · 9k+ posts · 18k+ votes
    7y

    @Raden Mantuano you need to set aside higher percentage for CAPEX for low dollar / low rent properties. You are only collecting $384 per year. That could be one appliance or flooring in one room. If you get into serious things like a sewer line or HVAC, it could cost thousands.

    Also please note that CAPEX and repairs are two different things. Repairs on a $40K house will be high, because my guess is that it is older or in bad condition. All sorts of things break. You have no idea what can break, until you own properties. CAPEX is for big items that need regular replacement like appliances, roof, flooring, HVAC, water heater.

    I don't think this is a good deal. I would negotiate the price down further and include a clause in your financing that allows principal pay down without penalty.

    Keep in mind financing can be more difficult to find on sub-$50K properties, so you may run into trouble when you go to refinance this.

    5Reply
  • Jason D.
    Rental Property Investor · St. Petersburg, FL · Member since 2017 · 3k+ posts · 4k+ votes
    7y
    @Raden Mantuano not only are you having to bank on appreciation, you are gambling on where interest rates are going to be in 9 years. When the loan is due, you'll either have to sell or refinance. You're, basically, talking about a 40 year loan on a $40k property. You're paying over $30k in interest over those first 9 years and will still owe the entire balance, then refinance for another 30 years. This property will cost you well over $100k in total. I'm sorry, but this seems like a disaster waiting to happen. If you really want this property, take a conventional loan on it. Take the money you say you have as repair reserves and use that as a downpayment. Your monthly payments will be less that in interest only payment you plan to make to the seller, and you'll be paying down the loan.
    9Reply
  • Raden Mantuano
    OP
    Member since 2018 · 53 posts · 10 votes
    7y
    Originally posted by @Jason D.:
    @Raden Mantuano not only are you having to bank on appreciation, you are gambling on where interest rates are going to be in 9 years. When the loan is due, you'll either have to sell or refinance. You're, basically, talking about a 40 year loan on a $40k property. You're paying over $30k in interest over those first 9 years and will still owe the entire balance, then refinance for another 30 years. This property will cost you well over $100k in total. I'm sorry, but this seems like a disaster waiting to happen. If you really want this property, take a conventional loan on it. Take the money you say you have as repair reserves and use that as a downpayment. Your monthly payments will be less that in interest only payment you plan to make to the seller, and you'll be paying down the loan.

    Can't all these negative out looks be offset by adding a few more properties under my belt that are cash flowing therefore having more cash at hand in the future?

    I guess.. the "A" action taker in me took over on this deal.. 

    0Reply
  • Jason D.
    Rental Property Investor · St. Petersburg, FL · Member since 2017 · 3k+ posts · 4k+ votes
    7y
    @Raden Mantuano sure they can, but I think you'll be starting out behind the 8 ball with this one. I'm a fan of multiple exit strategies when it comes to RE investing. With a property like this, you're stuck with no way to get out. Selling will be a loss, refinancing will be a loss, renting provides little to no cashflow. The advantage is that there is very little money up front, and you'll get the tax advantages. In my opinion, their may be why the seller is financing this for you.... he has found that there is no other way out from under it.
    0Reply
  • Raden Mantuano
    OP
    Member since 2018 · 53 posts · 10 votes
    7y

    Yea i guess, the best way im looking at it is.. 

    1.) I barely put anything down

    2.) It's a land contract so seller can take it back if I fail to make payments (Although that isn't my intentions)

    I am scheduling an inspection and property management walkthrough today.. and from there I can hopefully gauge how much in reserves i might need and need to save.. 

    0Reply
  • Nathan GesnerBusiness Member
    Moderator
    Real Estate Broker · Cody, WY · Member since 2010 · 28k+ posts · 41k+ votes
    7y

    @Raden Mantuano I'm confused. You tell me you're a REALTOR and have "income coming in" and you tell someone else you "have reserves and will have more." 

    Why did you have to borrow $500 if you have a reserve?

    IF you're going to ask a question, you should provide all the information. If the water heater springs a leak, do you have the money available to replace it? If the tenant fails to pay rent in March and leaves $2,000 in damages, can you handle the lost rent, the cost of repairs, and the vacancy?

    It sounds like you're banking on commission from a pending sale. I'm a REALTOR and know that this is exactly why so many REALTORS fail: don't count your chickens until they hatch.

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    8Reply
  • Raden Mantuano
    OP
    Member since 2018 · 53 posts · 10 votes
    7y
    Originally posted by @Nathan Gesner:

    @Raden Mantuano I'm confused. You tell me you're a REALTOR and have "income coming in" and you tell someone else you "have reserves and will have more." 

    Why did you have to borrow $500 if you have a reserve?

    IF you're going to ask a question, you should provide all the information. If the water heater springs a leak, do you have the money available to replace it? If the tenant fails to pay rent in March and leaves $2,000 in damages, can you handle the lost rent, the cost of repairs, and the vacancy?

    It sounds like you're banking on commission from a pending sale. I'm a REALTOR and know that this is exactly why so many REALTORS fail: don't count your chickens until they hatch.

    Hey Nathan, appreciate it. I know you’re looking out for me and I probably wasn’t clear. But yes I’m banking on commission, but also have a job. I borrowed $500 so that I didn’t have to use any of my fund or a little of my own money on this deal. 

    0Reply
  • Caleb Heimsoth
    Rental Property Investor · Durham, NC · Member since 2016 · 7k+ posts · 7k+ votes
    7y

    @Raden Mantuano. Multiple people on this thread are telling you not do this current deal as is. If you modify it a bit it could be a decent deal.

    Hopefully you listen to what everyone’s saying. Good luck

    2Reply
  • Raden Mantuano
    OP
    Member since 2018 · 53 posts · 10 votes
    7y
    Originally posted by @Caleb Heimsoth:

    @Raden Mantuano. Multiple people on this thread are telling you not do this current deal as is. If you modify it a bit it could be a decent deal.

    Hopefully you listen to what everyone’s saying. Good luck

    But why not give it a shot? I can learn more by doing it then reading it here tbh.. the thing is. 

    The risk in this deal for me is very minimal 

    0Reply
  • Caleb Heimsoth
    Rental Property Investor · Durham, NC · Member since 2016 · 7k+ posts · 7k+ votes
    7y
    Originally posted by @Raden Mantuano:
    Originally posted by @Caleb Heimsoth:

    @Raden Mantuano. Multiple people on this thread are telling you not do this current deal as is. If you modify it a bit it could be a decent deal.

    Hopefully you listen to what everyone’s saying. Good luck

    But why not give it a shot? I can learn more by doing it then reading it here tbh.. the thing is. 

    The risk in this deal for me is very minimal 

    Youre assuming the seller takes the house back and you’re assuming your reputation as an investor is nothing.  I wouldn’t assume either of those two things to be true.

    3Reply
  • Raden Mantuano
    OP
    Member since 2018 · 53 posts · 10 votes
    7y

    The reality of it is that yes, the seller can take the house back. However my rep as a real estate professional matters of course. So with everything else I’m doing - day job, Real Estate Sales, wholesaling, my digital marketing business. Everything that’s been said that I need to be prepared for can and is accounted for.. I’m also aiming for 5 more properties this year, so I will be  on a blitz. Also, refinancing with a blanket commercial loan based on the income that’s cash flowing should help me refinance easy in year 9. My risk tolerance is pretty high btw

    0Reply
  • Javier D.
    Investor · FL · Member since 2017 · 266 posts · 220 votes
    7y

    @Raden Mantuano

    Why are you asking. You are set on buying it. If the purchase price isnt 70% of market value or less I wouldnt buy it. If it is then go for it. Do your due dilligence on life expectancy of big ticket items.

    1Reply
  • Oliver Bergsjo
    Rental Property Investor · UT · Member since 2018 · 7 posts · 5 votes
    7y
    @Raden Mantuano it looks like you'll be cash flowing 1200 to 1400$ a year if nothing goes wrong (something always goes wrong) at the end of the 9 years you'll have 10800 to 12600$ (if nothing goes wrong) that's not even a third of the amount that will be due that's the first no from me. You're also on commission how are you supposed to float this payment when its vacant or a repair is need when the market drops and you don't have income (2019-2021 is when it's supposed to crash or get readjusted) that's the second no for me. When you have a fha or conventional loan you're paying primary and interest throughout the loan and the primary slowly increases creating you more equity in house, it seems that you will have only 500$ in equity for the next 9 years that's the third no for me. Real estate should be scalable this is putting you in reverse and isn't a good start for your portfolio that's the fourth no for me. You should only need one no to turn down a "deal"
    3Reply
  • Alexander Biniam
    Bristow, VA · Member since 2017 · 25 posts · 2 votes
    7y

    @Raden Mantuano Having not read your other posts, you seem to be just starting off your RE career with a complex seller financing deal that doesn't give you enough income to pay for the unknowns of life and pay off the balloon payment in the future. I think as everyone on this thread has said this is a bad deal made even worst with your mind already fixated on the deal. In this career, you must follow the math and the data -- ignore your emotions. If you are set on this deal, go for it but just know there were warnings. 

    2Reply
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